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Market Entry Strategy of Coca-Cola in China

The Chinese economic reforms started in 1978 by communist party to generate sufficient surplus value in order to finance modernization of economy (Wikipedia, 2009a). The reforms have been taken as series of phases which often was not the results of a strategy. Since starting economic reform, china has attracted many western companies (Prasad, 2004). The reforms were accompanied by liberalization in the foreign trade with attempting to attract foreign direct investment (FDI) (Fu 2000; Ng and Tuan 2002). China with 1.34 billion populations is a great target market for many multinational corporations (MNC). Coca cola is one of the biggest MNCs in the world that entered in china in 1979 just after starting economic reforms. Despite attractiveness of Chinese market due to unfamiliarity of market environment and dynamic legacy of economic reforms entry mode planning was a challenging effort. Here I am going to analyze the strategies adapted by Coca cola to the entry in Chinese volatile market in certain time frames.

Market entry modes review

According to the American Marketing Association (AMA) international marketing is the multinational process of planning and executing the conception, pricing, promotion and distribution of ideas, goods, and services to create exchanges that satisfy individual and organizational objectives (Onkvisit and Shaw, 2004). The critical issue in international marketing is market entry strategy. A market entry strategy is the planned method of delivering goods or services to a target market and distributing them there (Wikipedia, 2009b). Market entry mode has great impact on international operations and can be regarded as a frontier issue in international marketing (Wind and Perlmutter, 1977). In fact choice of market entry mode is one of the most critical strategic decisions for MNCs (Root, 1994; Nakos and Brouthers, 2002). Expansion into foreign markets can be achieved by following strategies (Quick MBA, 2009, Ferrell et al., 2008): Exporting and Importing Most companies get involved in the international market by importing and exporting. Exporting is the direct sale of products produced in a country in another country. This method is traditional and well established method of targeting foreign markets. The marketing often is trough an export agency to avoid international business complexity. Transportation, custom tax and export agency charges make the price of product higher and make it difficult for competition. Licensing and Franchising This method permits a company in the target country-the licensee- to use the property of the licensor that includes company name, products, patents, brands, trademarks, raw materials, and production process in the exchange for a fee or royalty (Ferrell et al., 2008). Licensing is an attractive alternative to direct investment when the market stability

is in doubt or when the resources are unavailable for direct investment (Ferrell et al., 2008). Franchising is a form of licensing that company provides a franchisee a name, logo methods of operations, advertisement, and other elements to conduct business, in return for a financial commitment and the agreement to conduct business in accordance with franchiser standards of operation (Ferrell et al., 2008). Licensing and franchising enable companies to enter to the international market without investing large sums of money and transferring resources abroad. In this way company will establish their image in the target country that will make future direct investment much easier. Joint Ventures In many least developed countries (LCDs) direct investment is limited or sometimes the company may lack sufficient resources to operate in foreign country (Ferrell et al., 2008). In that case a company may set up a joint venture by finding a local partner to share costs and operation of the business. Sometimes joint venturing is necessary to conduct giant business that no single company could do it. In this case companies are merging their resources to cover each other weakness and to learn from each other toward maximum benefit. However some conflicts between to parties may occur because of different identity of the companies, mistrust, performance ambiguity, cultural clash and leadership (Quick MBA, 2009). The key issues to consider in joint venture are ownership, control, length of agreement, pricing, technology transfer, local firm capabilities and resources, and government intentions (Quick MBA, 2009). Direct Investment Some companies that are willing to own whole facilities in conducting international business may consider direct investment that requires considerable amount of resources (Ferrell et al., 2008). These resources must be transferred to the target country. Direct investment maybe made through the acquisition of an existing entity or the establishment of new enterprise (Quick MBA, 2009). Many MNCs are willing to do direct investment. Direst ownership provides a high degree of control in the operations and ability to better know the consumers and competitive environment. However it requires a high level of resources and a high degree of commitment (Quick MBA, 2009).

Internalization theory propose that in case of high transaction cost which are caused by market imperfections, it is normally less expensive to use MNCs internal corporate structure to conduct business transactions rather than by relying on the market. Furthermore it suggests that rational maximizing MNC would tend to establish WOS in the form Greenfield investment or the acquisition of local firm in the host country. Other method could be JV but need to be rationalized economically that is more efficient than WOS to establish. The advantage of JV over WOS is the potential for revenue enhancing and cost reducing benefits. Lacking knowledge from specific nation such as the nature of the local market and local government could be costly for MNC to involve in writing, executing and enforcing contracts with market intermediaries.

Coca Cola Market entry mode in china

China has been successful in attracting FDIs since the implementation of economic reform in 1979. Joint ventures have been the most popular mode of entry with 56% of the total number of FDI firms in China until 2001(MOFTEC, 2002). Instead only 31% of the investments were in the form of direct investment (MOFTEC, 2002). This indicates popularity of joint venture in china. During three decade of economic reform the Chinese market still is new for foreign companies. China was a typical imperfect market for foreign companies as result of uncertainty, small number of agents, opportunism, bounded rationality and lack of knowledge about the local market (Mok et al, 2002). This market imperfection increase transaction costs considerably. Chinese market is not a single market and foreign firms need to respond to local rather than national market. Success of FDI in china depends on the decision what to produce and at which part of China. In addition it depends to the method of organizing business relations and dealing with local jurisdictions (Mok et al, 2002). Coca-cola decided to invest in china just after starting of economic reforms to get benefits of new and huge market. In order to deal with new and imperfect market Coca-cola applied different market entry modes in its entry strategy (Mok et al, 2002). To achieve innovative market accessibility, Coca Cola used different modes of market entry over 3 different stages. First stage- Franchise (1979-84) Franchise was Coca-Colas entry mode during this period. Coca-Cola started long negotiations with Chinese government immediately after lunching economic reform in 1979 to access the Chinese market. The negotiations resulted in sale of Coca-Cola only in three economic sites of viz. Beijing, Shanghai, and Guangzhou and only to foreigners at

specially designated retail outlets, such as hotels and Friendship Stores (Weisert, 2001). Coca-Cola built three bottling plants in Beijing (1981), Guangzhou (1983) and Xiamen (1984). Due to the restriction of Chinese government policy on the beverage sector Coca-Cola transferred all its ownership rights in bottling plants to various Chinese state-owned companies. In return, the Chinese-owned bottling plants bought concentrate imported by Coca-Cola. The bottling plants added syrup, water, sugar and gas (CO2) into the concentrate and the carbonated soft drinks were then ready to go to the market. At this condition CocaCola was just an exporter of concentrate, while bottling companies were producing and distributing whole market. It is clear that the profit from this agreement was considerably limited. As the bottling plants were owned by state owned companies, CocaCola didnt have any right to manage operation plants, control of volume of the production, sales or distribution strategy. It was not possible to have long term strategy on penetration into the vast Chinese market. In fact Coca-Cola lacked to have access to the market information by Chinese government. Besides, Coca-Cola faced problems of opportunism. Market agents were opportunistic because they wanted to focus on their bottom lines. This can largely be explained by the typical problem of a socialist regime in which the ownership rights of enterprises were not clearly defined (Mok et al, 2002). Apart from opportunistic behavior of bottling agents there were many problems on transport system and national wholesale system. The transport system was old and primary. Tricycles were the main mean of transport for soft drinks. The distribution channel was very costinefficient and time consuming. At that time no wholesale network existed. Facing these challenges Coca-Cola was not able to expand its activities. By 1984 there were only three bottling plants in China (Weisert, 2001). This kind of constraints hindered the long term objectives of the Coca-Cola in China. In fact at this time Chinese Government had tight control over the development of soft drink industry in China. Its objective was to protect local Chinese brands. This was mostly due to the shortage of fund for local soft drink makers to catch up with foreign soft drink makers, notably as Coca-Cola and Pepsi-Cola (Mok et al, 2002). Second stage-joint Venture (1985-92) In the mid 1980s Chinese government decided to implement liberalization policy to attract FDI. At this time planned to penetrate to the Chinese market. Coca-Cola tried to internalize its market

transactions by acquiring the management rights to bottling plants through making joint ventures (Mok et al, 2002). Chinese government permitted Coca-Colas bottling partner in Macau and a local enterprise in Zhuhai to form the first JV bottling plant in 1985. The next year the government permitted the company to sell its products to the Chinese people (Weisert, 2001). In order to manage the uncertainty of market expansion and to eliminate the constraints compounded by the opportunistic behavior of its local partners, Coca-Cola started to actively involve in the operation of the bottling plants by entering into JV arrangements with local partners (Mok et al, 2002). This marked the beginning of the second stage of mode of entry in China. However the Coca-Cola allowed to have minority of share within joint venture. In 1986 Coca-Cola was allowed to build a wholly owned concentrate plant. To keep concentrate plants in the form of WOSs was, and still is, Coca-Colas strategy to safeguard the formula of producing its concentrate (Mok et al, 2002). In return for the permission Coca-Cola give ownership of the bottling plant which was build jointly. The number of Coca-Colas bottling plants had increased rapidly from four in 1985 to ten in 1992. A decade after re-entering the Chinese market, Coca-Colas business in China started to become profitable in 1990 (Mok et al, 2002). In order to eliminate the opportunistic behavior of the market agents CocaColas strategy was to acquire management rights of its joint ventures regardless of its share. By this strategy Coca-Cola would have been able to control the bottling operation and the growth of Coca-Cola business in China. In addition, the local partners hoped to learn the management expertise of western MNCs. On acquiring management rights, Coca-Cola had the authority to appoint general managers to consolidate the production and marketing of its products in China (Mok et al, 2002). During this stage Coca-Cola faced many problems to further expand its business in China. Some of them were basically the same as those in the first stage. The behavior of local partners was still opportunistic. They wanted to concentrate only on their own bottom lines rather than focusing on increasing market share of Coca-Cola in china. The problem was raised from the fact that local partners didnt have a strong knowledge of the marketing concepts and market share. Another problem was Coca-Colas ignorant on understanding the financial difficulties that were faced by its local partners for a longterm expansion strategy of their JV businesses. This was largely because Coca-Colas partners were partially owned by local

governments or various ministries. They were too poor to finance the JV expansion (Mok et al, 2002). Each governmental manager must get approval of the government for any major decisions about additional investment from the JV partners. Furthermore the labour market was so rigid and the lack of experienced managerial staff to expand new plants. As a result, the companys market share increased only slightly during the second stage of its entry. Between 1992 and 1993, when local soft drink producers controlled up to 70 per cent of the market, Coca-Colas market share stagnated at 12 per cent ((Mok et al, 2002)).

Third stage (1993-present) To reduce the impact of the above problems, Coca-Cola internalized the market transactions through its strategy of long-term investments combined with its control of production and the domestic distribution channel. In addition, the company also internalized the procurement transactions and labour market of its bottling business by localising its management team and upstream suppliers. During the 1980s, most of the inputs, such as glass bottles, aluminium cans, polyethylene terephthalate bottles, were imported because the locally produced ones failed to meet the standard established by Coca-Cola. With technical assistance from Coca-Cola, a number of Chinese suppliers are able to produce the quality products demanded by Coca-Cola. Since the mid-1990s, more than 98 per cent of the supplies were sourced in the local Chinese market (AWSJ, 5 March 1996: 3; PU-TSUSC, 2000: 22-23). For the market expansion in China, Coca-Colas strategy was to ensure that the company was not excessively involved in production and distribution. A cost-effective way to reduce risk and to overcome the problem of shortage of human resources was to manipulate the business functions indirectly through a franchise arrangement with foreign partners.13 As such, Coca-Cola teamed up with two foreign bottlers, namely Malaysias Kerry Group and Hong Kongs Swire Group. The Swire Group mainly produces and distributes Coca-Cola products in southern and central China, while the Kerry Group focuses on northern and interior China. These foreign partners were able to bring in capital and human resources. The Coca-Cola bottling business was undertaken in the form of a JV between Coca-Cola and its local partners. 14 The involvement of the Kerry Group and the Swire Group was in the form of a franchise agreement with Coca-Cola. This arrangement has shaped the basic features of the third stage of Coca-Colas business development in China (Field survey, 1999). Together, Coca-Colas franchising arrangements with foreign partners (i.e., the Kerry and

Swire Groups) and its JVs with Chinese partners constitute the main elements of the companys internalization strategy. Franchising is a method of producing and/or marketing goods and services in which the franchiser customarily grants the franchisee the right, or privilege, to operate the business in a prescribed manner over a period limited by the term of the franchise agreement. A large element of the franchise represents the market alternative to the internalized transfer of managerial and marketing skills (Buckley and Casson, 1985: 45-49). In the case of Coca-Cola in China, the transfer includes manufacturing technology (Field survey, 2000). Mendelsohn and Bynoe (1995: 7) noted that the investment in and ownership by the franchisee of the franchised business is a key feature (of franchising) since the franchisee is committed by his investment and expected, as owner, to be better motivated than would be a manager. Although there are references to the business being owned by the franchisee, there are two factors that make that ownership different from that enjoyed by a non-franchised businessman. The franchisee must operate under the franchisers name, using his system and within the terms of the franchise agreement. They added that the ability of a franchised business to achieve growth is by linking the franchiser with his franchisees, who possess the capital and manpower to operate the business. This type of agreement fundamentally addresses the shortages of capital and human resources faced by Coca-Cola in its strategy of expanding market share in China. The above mode of investment by a hybrid of JVs and franchising could potentially bring in revenue-enhancing, cost-reducing and riskavoiding benefits to Coca-Cola. Coca-Cola possesses rent-yielding assets, viz. the technology of producing Coca-Cola and marketing expertise. Its local partners have the advantages of strong distribution arms and knowledge of local beverage markets (the nation-specific knowledge mentioned by Beamish (1988: 106)). The Kerry and Swire Groups are rich in cash, share the goal of long-term profit and market share maximization of Coca-Cola, and have strong political connections to the Chinese Government. The synergistic effect of combining the assets of various parties appeared to achieve the objective of maximization of Coca-Colas beverage market share in China. For instance, Coca-Cola was able to capture a market share of 40 per cent in 2000, almost three times that of Peps-Cola, its close international competitor (Table 3). These revenue-enhancing and cost-reducing potentials in JVs outweighed the advantages of WOSs. One way to guarantee these benefits was to make sure that the Kerry and Swire Groups obtained management rights in overseeing the bottling plants and assuming direct control of distribution via the acquisition of majority shares in the JV bottling business in China. The Kerry Group has in fact obtained about 50-60 per cent equity shares of all its bottling plants, while the Swire Group was able to keep a controlling

block of shares at 51 per cent in the bottling plants under its management control (Field survey, 1999 and 2000).15 It has been argued that ownership is often used to control residual rights in international operations. An MNCs ownership share in its foreign operation reflects the importance of the assets used in its operation and more importantly the bargaining power relative to its local partners (Nakamura and Xie, 1998: 571-99). Coca-Cola started to negotiate with the Chinese Government in the early 1990s to buy-out the majority shares of all existing and newly planned bottling plants. The negotiation process was lengthy and difficult. The local partners were demanding high prices for the buy-outs, based on unreasonably high levels of projected future earnings.16 How to resolve the problem often relates to the art of give and take. The prime wish of the Chinese Government was for Coca-Cola to transfer its asset-specific knowledge and equipment in beverage production to its local partners to develop local branded beverages (SCMP, 27 January 1994: 14). This arrangement could be worked out in the form of a JV. For example, through the set-up of a new 50-50 JV in Tianjin with Chinas Ministry of Light Industries, Tianjin Jinmei Beverage Co. Ltd., Coca-Cola has been helping its local partners in Tianjin to develop some local branded drinks, e.g. Xingmu (Smart) soft drinks, TianYuDi (Heaven and Earth) fruit juice drinks, tea and bottled mineral water (Wang, 1998).

All in all, these studies confirm that both economic advantages and institutional incentives attract FDI to China. However, the studies focusing at the macro level dismiss two crucial aspects. First, China cannot be modelled as one, let alone one integrated market. Thus foreign firms need to respond to local rather than national boundaries of markets and institutions (e.g. Dollar et al. 2003). Second, the success of FDI in China depends crucially on the activities of foreign firms in particular their decision what to produce and where in China, how to organise business relations and how to deal with local jurisdictions. Thus it is assumed in what follows that a firm-level analysis is needed to identify (systematic) factors by which the specificity of FDI in China and the performance of the FDI sector can be explained. Studies in international business and strategy addressing this issue point to the importance of choosing the right entry strategy, responding flexibly to the local environment while developing the capacity to adapt to changing circumstances (e.g. Caves, 1996; Ghemawat, 2003). In the following, we discuss entry choices and local embeddedness of foreign firms in China respectively, attempting to sort out the major underlying considerations and their dynamic features to understand the behaviour of foreign firms in China.

Entering multinational companies (MNC) to the new markets are costly. Most of this cost is related to the transaction costs. Williams (1975) outlined that these costs comes from problems of opportunism, few market agents, uncertainty and bounded rationality. He argued that transaction cost of writing, executing and enforcing contractors are higher than cost of internalizing the market. For this reason MNCs will prefer wholly owned subsidiaries (WOS). Other models like joint ventures (JV) are also common. In this study applicability of internalization theory in entry mode of MNCs in developing countries is examined based on case study of Coca Cola in China.

The entry choice of MNCs:

Internalization theory propose that in case of high transaction cost which are caused by market imperfections, it is normally less expensive to use MNCs internal corporate structure to conduct business transactions rather than by relying on the market. Furthermore it suggests that rational maximizing MNC would tend to establish WOS in the form Greenfield investment or the acquisition of local firm in the host country. Other method could be JV but need to be rationalized economically that is more efficient than WOS to establish. The advantage of JV over WOS is the potential for revenue enhancing and cost reducing benefits. Lacking knowledge from specific nation such as

the nature of the local market and local government could be costly for MNC to involve in writing, executing and enforcing contracts with market intermediaries.

How JV can reduce transaction costs?

JVs can mitigate the problem of opportunism based on mutual trust between MNC and local partner to ensure long term viability of their JV. If the profit division, joint decision making and monitoring are well developed to keep the viability of a long term profits there will be less reason for both parties to switch partners. In the uncertain market JV need to be formed in order to economize the information requirements for foreign direct investment (FDI). The objective can be received by combining the resources of MNC and its local partners. There is no evidence that problem of bounded rationality can be less in JV than in WOS.

FDI in China:
China was successful in attracting FDI since implementation of economic reform in 1979. EJV was the most popular mode for MNCs to enter the Chinese market (45% in compare to 31% WOS). China was a typical imperfect market for FDI since for two decades of economic reform the Chinese market remained relatively new territory for foreign firms.

Coca Colas choice of entry mode in china:

Using franchise agreement Coca Cola faced shortage of capital and human resources in its strategy of expanding market share in china. Employing hybrid method of JV plus franchise could potentially bring revenue enhancing, cost reducing and risk avoiding benefits to Coca Cola. Local partners have the advantage of strong distribution arms and knowledge of local market which in combine with Coca cola production technology and marketing expertise will enhance revenue and reduce costs. These revenue enhancing and cost reducing potential of JVs outweighed the advantage of WOSs. At 1990s Coca Cola were negotiating with the Chinese government to buyout majority of all existing and newly planned bottling plants. But the negotiations were tough and time consuming. The prices were unreasonably high and government wanted coca Cola to transfer its assetspecific knowledge and equipment to its local partners to develop local branded beverage. This arrangement could be worked out in the form of JV.

Coca-Cola's long-term strategies of localizing production and building infrastructure through partnerships with the Chinese government and domestic companies have allowed it to establish nationwide operations and generate a strong market presence. Coca-Cola products currently account for 35 percent of China's carbonated beverage market and generate annual sales of up to $1.2 billion, according to press reports. The company has earned a gross profit in China each year since 1990. ( During the first two stage of market entry Coca Cola faced four major challenges in its long term development strategy: 1- Initially the Chinese market was highly fragmented and whole sale/distribution system was old. Coca Cola doesnt have access to the operation of bottling plants. 2- Local partners played a passive role in the Coca Colas market entry. They were opportunistic and self interest companies without long term development strategy. 3- Chinese government had full control over development of soft drink industry and was careful to uphold local brands. They did not allow Coca Cola to enter into JV until 1985. 4- The local partners were too poor to finance further business expansion. They were owned partially by government and any decision on JV had to gain official approval. First two challenges can be regarded to high transaction costs that were incurred through uncertainty in the market environment and opportunistic behavior of market agents. The following two challenges were consequence of bounded rationality. In order to overcome these problems Coca Cola internalized market transactions through a strategy of long term investment with the approval of government. Coca cola could increase its control on production and distribution by acquisition of majority stakes. However this was costly and need to reduce risk of direct investment. In order to reduce the risk coca Cola teamed up two foreign bottlers under a franchise agreement. By this combination Coca Cola delivered revenue-enhancing and cost reducing benefits.

The study shows that internalization theory can explain the entry mode choice of Coca Cola in china. The findings also provide an insight into market expansion strategy of a global soft drink manufacturer in china. To understand the changes of Coca Colas mode of entry from franchise to JV and hybrid, internalization theory employed to address the effect of various entry modes to reduce the market imperfection. Furthermore these changes guarantied steady growth in market and high degree of penetration. Internalization theory can be a good framework to choose mode of investment in china. But the government policies and national culture are also influential.

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